Pages

Monday, 6 October 2014

Europe must learn from the US

This article was published in The Malta Independent on Sunday - 05 10 2014

Europe has again defeated the US in the Ryder Cup. In golf there is nothing we need
to learn from the US. But in the
handling of the economic crisis there is much that Europe needs to learn, and
fast.

Six years after the financial crisis of 2008 that
nearly brought the total collapse of the international financial system as
credit froze and banks were losing the trust of their depositors, the US is now
flying high again.

This week we had
figures showing that the US economy has continued to add employment at a fast
pace bringing the unemployment rate below 6% for the first time since the
crisis. The US dollar rate of exchange
index is soaring as America becomes the world’s leading producer of energy and
is in a position to start exporting it, in the process pushing down energy
prices.

The only blot on the US
economic performance is that economic growth is not well distributed, with the
top echelons of society grabbing most of the fruit of economic revival whilst
workers’ wages remain stuck at pre-crisis levels. But this is a process which will sort-out itself if economic growth proceeds unabated as
shortage of labour will eventually inevitably translate into higher wages
without pushing up inflation, given the productivity gains accompanying economy
growth and falling commodity and energy prices.

Europe, especially the Euro area, is a complete
antithesis of the US success. Unemployment remains stubbornly high and a
generation of youth is being lost as they cannot participate at all, or at
least not to the best of their abilities, in an economy stuck in a crisis. Countries
that were most hit by the crisis due to their deficit and debt levels at the
point of crisis entry have undergone several rounds of crushing austerity
measures but they have not much to show for it.
They are stuck in an economy that has all characteristics of deflation,
with falling prices, high unemployment, lack of investment, gummed bank credit
and their burden of debt is getting heavier as they are caught in a
deflationary debt trap.

From Malta this view seems unreal as thank God our
economy has continued to perform and indeed accelerate more in US style rather
than European style. But we are the
exception to the European rule and let us not kid ourselves: if the European crisis prolongs our economic
performance will be hit too as demand for our exports of goods and services is
mainly sourced from the EU.

The obvious question is what has caused this
difference in results between the US and the EU, particularly the Euro area. The problem was largely the same so why in a
such an economically inter-connected world the youth in Pennsylvania are
finding work, even if not well paid, whereas the youth in Portugal have no
jobs?

Clearly this has been due to the different response to
the crisis between the US and Europe.

The US as a single Federal State with a Federal
Congress, an elected Federal Executive and a single Treasury and Central Bank
could respond more forcefully and punctually to the crisis. Although not to the degree desired by
Keynesian economists like Paul Krugman, Larry Summers and Joseph Stiglitz, fiscal policy was
complementary to the aggressive monetary policy which brought interest rates
down to zero. When that was not enough the Federal Reserve made three rounds of
quantitative easing buying long term government bonds and mortgage backed
securities to bring down long term interest rates, giving banks space to
entertain fresh credit demands and in the process stabilising and reviving the
housing market. More than anything else
the US immediately addressed the capital deficiency problems of its banks,
resulting from losses they suffered in the crisis, using fiscal policy to
re-capitalise banks so that they could immediately become active players in the
revival of economy.

The US recipe which is proving so successful was based
on three pillars:

Immediate
re-capitalisation of Banks through TARP funds approved during the last days of
the Bush administration.

Fiscal
stimulus given by the Obama administration soon after executive takeover.

The European response was piecemeal, uncoordinated and
altogether insufficient.

There was and still there is no adequate reply to the
capital deficiency of European banks.
Bank stress tests undertaken in various rounds were too soft and failed
to serve any purpose. Even the current
process of Asset Quality Review to be followed by aggressive stress tests is half
baked. Without a ready fund which can
be used to fill up any capital deficiency holes, it is like risking starting a
fire without having an extinguisher at the ready. As in the US, Europe needed to use fiscal policy to create
such a TARP like capitalisation fund.
And the burden for such funds should have been pan-European. No use expecting countries struggling with
excessive fiscal deficits, within a currency bloc they do not control, to use
more fiscal funding for their banks’
capital deficiency.

Instead of fiscal stimulus Europe imposed harsh
austerity programmes. The word
austerity was not in the US lexicon for handling the crisis. Austerity crushes demand leading to economic
contractions, larger deficits and yet more austerity. It is a spiral which like a slippery slope is
hard to break. Europe needed restructuring of the disequilibria in countries
like Ireland, Portugal and Greece but this had to be compensated by creation of
compensating demand in surplus countries.
Instead surplus countries like Germany also adopted austerity and
balanced budgets when their excessive balance of payments surplus needed a
totally opposite approach.

And lastly the only institution in the EU which has
autonomous authority to work in a Federal-like manner, the ECB, was not
forceful enough with loosening monetary conditions. One can mention the interest rate increases
in 2011 which were a heresy in the context they were applied and had to be
immediately reversed. When the
zero-interest bound was reached the ECB could not move into quantitative easing
as fast as the US Fed and only now that inflation in the Euro area overall has
fallen to 0.3% (meaning that problem countries are effectively in deflation)
the ECB is finding the courage to do some altogether inadequate quantitative
easing. In the process it is finding
harsh criticism from German quarters who only respect the independence of the
Central Bank when it suits them.

The stasis in the EU organisational structure is
becoming a serious threat to its own existence. Democracy cannot take endless rounds of
austerity without at least a credible light at the end of the long and dark economic
tunnel. Inevitably such dissatisfaction
will become easy prey for extremist demagogues of the left or right who promise
easy solutions which will challenge the whole EU structure and stability. Papendreou and Berlusconi were practically
forced out of power from Berlin but they were losing support in their home
ground in any case. What would happen
if Marine Le Pen will be the next democratically elected President of France
with a popular mandate to break all the EU and Euro rules?

If the EU and the Euro are to be saved there is not
much time left to revise our response to the crisis and build on the model of
the US measures that proved effective.
Obviously institutional arrangements are difference and a direct copy is
impossible. But the general message is
that the ECB as the only pan European institution with autonomous power that
give it the flexibility to move fast and effectively, have to deliver through
its monetary policy and macro-prudential mandates solutions that carry the load
that fiscal policy cannot shoulder
within the current EU institutional framework.
It can be done if countries respect the ECB independence all the time
not just when it suits them.